Economists Voice Support for California Cap-and-Trade Auction

This week, nearly 60 renowned economists and other experts around the country sent a letter to Governor Jerry Brown emphatically voicing their strong support for the design of California’s groundbreaking cap-and-trade program, a key element of the Global Warming Solutions Act (AB 32).

Sent just days before the expected simulated auction of greenhouse gas allowances, the letter to Brown commended his leadership “in implementing the world’s most comprehensive climate law” and his commitment to auction allowances – rather than give them away free – “as part of the crucial launch phase” of the cap-and-trade program, one of the critical strategies California is pursuing to achieve AB 32’s mandate to reduce California’s carbon pollution to 1990 levels by the year 2020.

“Auctioning allowances generates proceeds for government to redistribute to households, reduce other taxes, or achieve further environmental and equity goals that otherwise may not be achieved if allowances are given for free,” the economists noted in the letter.

As the California Air Resources Board prepares for Thursday’s planned simulation in the run-up to the Nov. 14 auction, there have been 11th hour calls from opponents to modify, delay or outright cancel the auctions, which are an integral component of the overall program .

A number of economists and experts, however, urged that the quarterly auctions proceed as planned, emphasizing that giving away all the allowances could result in windfall profits to industry.

“In most situations businesses are able to pass the market value of allowances through to consumers, even though they themselves received allowances for free,” the letter noted. “Canceling or scaling back the auction would simply result in a wealth transfer to covered entities beyond anyone’s expectations and disrupt the current design of the AB 32 cap-and-trade program.”

The program sets a “cap” on the aggregate emissions from the state’s largest emitters but does not dictate specific reduction requirements on any one emitter, allowing them flexibility to buy and sell (“trade”) pollution credits, known as “allowances,” at quarterly auctions or on the market in order to comply. Each year the cap declines, meaning there are fewer allowance available (not unlike musical chairs), and industry must reduce emissions or pay increasingly higher prices for allowances to account for their carbon pollution.

The economists noted “the most important aspect of a cap-and-trade system is the actual cap” to reduce pollution and therefore, in theory, the program’s environmental integrity doesn’t change whether the allowances are auctioned or given away.

“In reality though, once real-world conditions are introduced, the difference matters,” they added. “These conditions include transactional costs, unfair market power, uncertainty, allowance allocation formulas that may be based on output or other changeable conditions (even with the expressed intent to reduce leakage), and other industry market behaviors that can introduce inefficiencies into perfectly functioning markets.”

The experts, who hail from a variety of colleges and universities inside and outside California, pointed out that covered entities have known since the 2008 adoption of the AB 32 Scoping Plan that an allowance auction would be part of the nation’s first economy-wide greenhouse gas cap-and-trade program, providing ample time to prepare. Utilities and large industrial facilities like oil refineries and cement manufacturers will be covered first, with transportation fuel and natural gas distributors joining them beginning in 2015.

“That auction is much more than a mere ‘price finding’ exercise. It establishes the fact that businesses will pay for some portion of their carbon pollution,” the letter said.

The signees included leading climate economist Dallas Burtraw, who earlier this year testified that California’s program is the best designed cap-and-trade program anywhere in the world. One of the nation’s foremost experts on environmental regulation in the electricity sector, Burtraw also told the Senate committee the cap-and-trade approach “has been put into practice many times, especially in the regulation of air pollution, and can be attributed with cost savings of billions of dollars compared to traditional regulatory approaches.”